BackToBasics
Cash budgets
As the old adage attests: ‘Turnover is vanity, profit is sanity but cash is king’. Here’s why
Words Nick Craggs, First Intuition Illustration Jackie Parsons
Having actual money in the bank is crucial to a business and there are numerous examples of profitable businesses that ran out of cash, then failed. These include Blockbuster, although it is fair to say Netflix didn’t help its chances either.
It is all very well making lots of sales, but if customers are taking three months to pay you, and you need to pay your suppliers next month and your workers this month, you are in trouble. It’s unlikely your staff would be willing to work unpaid until your customers pay you. And if your workers aren’t working, you are out of business.
A business can use a cash budget to manage its cash flow and anticipate its cash balances over the coming months, allowing it to manage any periods where cash might be tight.
Key point
There is a reason that cash is king. Having it available allows you to meet your obligations to your staff and suppliers. Operating a cash budget enables you to anticipate when there may be fluctuations in your income and/or outgoings, and to adjust accordingly.
A business can use a cash budget to manage its cash flow and anticipate its cash balances over the coming months.
Money in
When preparing a cash budget, I like to start on a positive note and look at the cash coming in. A company may well offer 30 days’ credit to its customers, and in a perfect world everyone would pay in 30 days. However, we don’t live in a perfect world, and businesses will need to deal with late payers or even non-payers.
History can guide a business as to what cash it is likely to receive and when. Let’s look at an example where a business has budgeted it will make £100,000 in sales in January. Past history indicates that 10% of those sales will actually be cash customers. It also suggests that 70% of these sales will be made to customers who pay in the required 30 days. Another 15% of those sales will be to customers to pay between 30 and 60 days, which leaves 5% who will, unfortunately, just not pay.
So, the cash receipts look like this:
Moving on, the company might be planning to make sales of £110,000 in February, but the periods in which its customers pay stay the same, with the usual 5% who don’t pay.
The cash receipts now look like this:
Finally, if we anticipate March’s sales to be £120,000 and April’s sales to be £105,000, our cash budget now looks like this:
Money out
We now have the full receipts for March and April. January and February would have some receipts from the previous year that we haven’t calculated. We can now turn our attention to the other side, which is money leaving the business.
Looking at wages first, we will assume this is a variable that costs the business 20% of the sales made that month as the employees are paid at the end of each month. If we only look at March and April, as these are the only two months that we have the full receipts for, we can see that the wages the company will need to pay each month will look like this:
Paying suppliers
The company will have its own suppliers to pay for materials and, to make matters easier, let’s pretend it is a good company that pays everyone in the agreed 30-day terms. Again, let’s assume materials is a variable and costs 30% of the sales made each month, but the company will physically pay for this in the following month.
To calculate the payments to suppliers made in March and April, we will need to look at the sales made in February and March:
Rent
Lastly, let’s look at one final cost – rent. We could say that rent is paid in advance on the last day of each month for the use of the factory for the following month. The rent also increases by 10% every April for the new tax year. If the rent was £5,000 per month originally, our cash budget for March and April will show a payment of £5,500 each month as, although the rent increase kicks in from April, the first payment of this amount will be made on the last day in March:
Net cash flow
To finalise the cash budget, if we take the cash inflows and cash outflows then we can calculate the net cash flow for each month. And if we take the opening cash position we can calculate the cash balances over the period. If there was an overdrawn balance of -£50,000, we can see it isn’t until the end of April that the business will get back into a cash-positive position:
This allows the company to anticipate when it might have some shortfalls in its cash position and it may want to take some action to avoid these. For example, it may delay the purchase of a large piece of machinery or take some money out of investments for a period of time to cover this. Conversely, if there are going to be periods where it is anticipated that cash is not going to be an issue, the company may look at what short-term investments it can make, rather than having cash not earning a great deal of money in a current account.
